Avi-Yonah: Is A Mark To Market Tax Constitutional After Moore?

TaxProf Blog Op-Ed:  Is a Mark to Market Tax Constitutional After Moore?, by Reuven S. Avi-Yonah (Michigan; Google Scholar):

The main reason the Supreme Court granted certiorari in Moore was not to debate the constitutionality of the Mandatory Repatriation Tax (MRT). If that were all, there would be no need for any of the Justices to address whether taxation without realization is constitutional, because the MRT clearly involves income that was realized. As Justice Kavanaugh wrote for the majority,

Our analysis today does not address the distinct issues that would be raised by (i) an attempt by Congress to tax both the entity and the shareholders or partners on the entity’s undistributed income; (ii) taxes on holdings, wealth, or net worth; or (iii) taxes on appreciation...Those are potential issues for another day, and we do not address or resolve any of those issues here. Moore, at 8 fn. 2, 22.

This outcome was not satisfactory for either the concurrence or the dissent, who were eager to address precisely the question that the Court leaves unaddressed. In concurrence, Justices Barrett and Alito state that,

The question on which we granted review is “[w]hether the Sixteenth Amendment authorizes Congress to tax unrealized sums without apportionment among the states... The answer is straightforward: No.” Moore, concurrence at 2.

And in their dissent, Justices Thomas and Gorsuch state that,

Sixteenth Amendment “incomes” include only income realized by the taxpayer. The text and history of the Amendment make clear that it requires a distinction between “income” and the “source” from which that income is “derived.” And, the only way to draw such a distinction is with a realization requirement. Moore, dissent at 1.

The reason the concurrence and dissent address the constitutionality of realization is that this was why they granted certiorari. The main target of Moore was not the MRT, but the billionaire mark to market tax proposed by Senator Wyden and by President Biden.

Therefore, the most interesting question after Moore is whether such a tax remains viable.

On its face, the answer is yes, because the majority explicitly avoided ruling on its viability. But it is also clear that there are four Justices eager to declare it unconstitutional, and it would be a brave Congress that would pass such legislation given that it would only require Justice Kavanaugh or Chief Justice Roberts to join them to invalidate it. Only Justice Jackson clearly supports taxation without realization.

Nevertheless, Congress should pass this legislation. Taxing the super-rich is as essential now as it was in 1909 when the Sixteenth Amendment was first proposed or in 1913 when it was adopted, because the level of inequality is as high as it was then. And mark to market taxation is the best way to tax the super-rich because they never need to realize income; they just need to borrow against the unrealized appreciation of their assets, as Elon Musk showed when he bought Twitter.

Nor is it clear that Justices Barrett and Alito would necessarily strike such a tax down. Justice Barrett writes that,

but whatever my disagreement with the Court’s reasoning, it bears emphasis that the Moores’ case involves the Mandatory Repatriation Tax (MRT), which is a specific tax imposed upon the American shareholders of a closely held foreign corporation. A different tax—for example, a tax on shareholders of a widely held or domestic corporation—would present a different case. Moore concurrence, at 1.

This indicates that she would consider Subpart F (including GILTI) to be constitutional, at least where control is involved.

But what about taxing Messrs. Bezos, Musk or Zuckerberg on the income realized by the corporations they control? These are widely held domestic corporations, so that Justice Barrett would presumably not approve of taxing all their shareholders on the corporate income. But it is not clear she would disapprove of taxing the controlling shareholders on the corporation`s income.

It is hard to distinguish a tax on the undistributed realized income of a controlled foreign corporation from a tax on the undistributed realized income of a controlled domestic corporation. In 1937, Congress felt that it could not impose tax directly on a controlled foreign corporation, and that is why it invented the deemed dividend mechanism to tax foreign personal holding corporations (FPHC). But that is no longer true today, when the accumulated earnings tax, the personal holding corporation (PHC) tax, and the corporate AMT are all imposed directly on foreign as well as on domestic corporations. The FPHC regime was abolished in 2004 precisely because Congress realized that it was superfluous given that the identical PHC regime applies to foreign corporations.

But there is still a risk that five Justices would strike down the legislation. This is why I suggest an amendment based on the work of Profs. Brian Galle, David Gamage and Darien Shanske[1]:

Congress should apply the PFIC regime to the billionaire owners of controlled domestic corporations like Alphabet, Amazon, Meta and Tesla. Under the PFIC regime, shareholders are given the choice of either (a) current taxation or (b) mark to market taxation or (c) deferred taxation upon realization with an interest charge. Most shareholders choose option (a) because option (b) risks taxation on “phantom income” that will disappear if the stock market value falls, and option (c) involves a hefty interest charge and thus a massive one-time tax payment.

Such an elective regime would be harder for the Court to strike down precisely because it is elective. If option (c) is constitutional because it involves realization at the shareholder level, it is hard to declare options (a) or (b) unconstitutional because the shareholder could choose option (c) instead.

In addition, Congress should ensure that option (c) cannot be avoided by applying the current exit tax on expatriation to death and charitable donations as well. These are all excise taxes under the Court`s jurisprudence, and therefore constitutional.

[1] See Brian Galle et al., Solving the Valuation Challenge: The ULTRA Method for Taxing Extreme Wealth, 72 Duke Law Journal 1257-1343 (2023) [reviewed by Young Ran (Christine) Kim (Cardozo; Google Scholar) here)].

TaxProf Blog Op-Eds on Moore v. United States, No. 22–800 (June 20, 2024):

• Lawrence Zelenak (Duke), Moore Thoughts (June 21, 2024)
• Conor Clarke (Washington University), Four More Takeaways From Moore (June 22, 2024)
• Reuven Avi-Yonah (Michigan), Is A Mark To Market Tax Constitutional After Moore? (June 23, 2024)
• John Brooks (Fordham) & David Gamage (Missouri-Columbia), Moore v. United States: Initial Reactions (June 24, 2024)
• Brian Galle (Georgetown), What's Next For Wealth And Mark-To-Market Taxes After Moore?
• Andy Grewal (Iowa), Moore Decides Less (June 26, 2024)
• Michael Graetz (Columbia), Moore v United States—Winning the Battle but the War Goes On (June 27, 2024)
• Alex Zhang (Emory), Moore And The Judicial Role In Tax Law (June 28, 2024)